The opinion
T.C. Memo. 1996-432
UNITED STATES TAX COURT
JAMES B. MILLER, JR., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7900-94. Filed September 24, 1996.
James B. Miller, Jr., pro se.
Alison W. Lehr, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: Respondent determined deficiencies and
accuracy-related penalties relating to petitioner's 1990 and 1991
Federal income taxes as follows:
Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1990 $21,617 $4,323
1991 $18,156 $3,631
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After settlement of some issues, the issues for decision
are: (1) Whether petitioner is entitled to deduct expenses
relating to a home office; (2) whether petitioner has adequately
substantiated claimed business expenses relating to his scrap
metal recycling business; and (3) whether petitioner is liable
for the accuracy-related penalties.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. At
the time he filed his petition, petitioner resided in Lake Worth,
Florida.
During 1990 and 1991, petitioner owned and operated as a
sole proprietorship a scrap metal recycling business. Suppliers
would deliver scrap metal to the warehouse petitioner rented for
his business, or petitioner or his employees would pick up scrap
metal from suppliers and bring it to petitioner's warehouse.
None of the scrap metal was ever brought to petitioner's
residence in which petitioner maintained an office (home office)
for the performance of administrative and management work
relating to his scrap metal recycling business.
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At petitioner's warehouse, scrap metal was prepared for
resale and shipped or delivered personally by petitioner or his
employees to wholesalers throughout southern Florida.
Petitioner maintained the home office because there was no
suitable space in the warehouse for him to perform necessary
administrative and management work relating to his scrap metal
recycling business. Most of the time during which petitioner
worked on his scrap metal recycling business, petitioner was
physically located in his home office.
Petitioner used the home office mainly to place telephone
calls to potential customers and to maintain data and
spreadsheets on his computer relating to operation of his scrap
metal recycling business. Over the telephone from his home
office, petitioner generally made arrangements for the purchase
and resale of scrap metal. Telephone calls received at the
warehouse were routed first to the home office and then, if not
answered at the home office, were transferred to the warehouse.
Petitioner prepared at his home office advertising material,
brochures, and fliers to mail to customers. On such material,
the address indicated for petitioner’s business was the warehouse
address, not petitioner’s home address.
Petitioner often would meet with customers at their places
of business. Other than for entertainment, petitioner never met
with customers in his home office.
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Petitioner visited the warehouse frequently in order to,
among other things, check on employees and operations at the
warehouse, deliver supplies, and pick up and deliver cash -- the
form of payment typically used in petitioner’s scrap metal
recycling business.
During most of 1990, petitioner lived in a rented residence
with two of his daughters and his girlfriend at 7350 Estrella
Court, West Palm Beach, Florida (Estrella residence). The
Estrella residence consisted of a kitchen, a combined living and
dining room area, a family room, four bedrooms, 3.5 bathrooms, an
attached garage, and a swimming pool. Petitioner often
entertained personal and business guests at dinner parties at the
Estrella residence.
From the end of 1990 through 1991, petitioner lived in a
condominium that petitioner owned at 614 N.W. 13th Street, Boca
Raton, Florida (condominium). The condominium consisted of a
kitchen, a combined living and dining room area, two bedrooms and
1.5 bathrooms. Two of petitioner's daughters occasionally lived
with petitioner in the condominium.
During 1990 and 1991, petitioner’s home office relating to
his scrap metal recycling business was located in the combined
living and dining room area of both the Estrella residence and
the condominium. Petitioner furnished the living and dining room
area with desks, file cabinets, a computer, and calculators. The
record does not indicate what other furniture was located in the
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living and dining room area. Petitioner had six telephone lines
running into the home office.
As indicated, petitioner paid employees of his scrap metal
recycling business in cash. Employees of petitioner’s scrap
metal recycling business were generally hired on a temporary
basis by petitioner’s warehouse foreman. The employees generally
were transient or homeless individuals and worked in the
warehouse. Employees of petitioner’s scrap metal recycling
business were required to sign a written agreement, but there was
no line on the agreement to indicate an employee's Social
Security number or personal address, and neither petitioner nor
the warehouse foreman generally obtained Social Security numbers
or addresses of the employees.
Petitioner did not prepare and submit Forms W-2 or 1099 with
respect to wages paid to employees of his scrap metal recycling
business, and petitioner withheld no Federal or State taxes with
regard to wages paid to his employees.
At the end of each day, petitioner’s warehouse foreman would
prepare a written cash report and would indicate thereon amounts
paid and received that day from the purchase and resale of scrap
metal, wages paid to employees, and expenses paid at the
warehouse. Generally, at the end of each day the warehouse
foreman also would call petitioner and provide petitioner with
information concerning the cash received and spent at the
warehouse that day.
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The cash reports that were prepared each day by the
warehouse foreman would be reviewed every few days by petitioner,
who would enter data from the cash reports onto spreadsheets
petitioner maintained on the computer located in his home office.
Prior to trial, the majority of the written daily cash reports
relating to petitioner's scrap metal recycling business were lost
or misplaced. Petitioner's computer spreadsheets with regard to
employee wage expenses incurred at the warehouse generally
correspond with information with regard thereto as reflected in
the limited number of daily cash reports that are in the record.
According to petitioner's computer spreadsheets, the
warehouse foreman received total wages of $19,798 in 1990 and
$20,956 in 1991.
Petitioner’s employees occasionally incurred traffic fines
for speeding and other traffic violations while picking up or
delivering scrap metal.
During 1990 and 1991, petitioner's warehouse was broken into
and burglarized several times. Reports were made to the police,
but petitioner did not retain copies of the police reports or
other records indicating what was stolen from petitioner’s
warehouse.
In late 1990, due apparently to pending litigation involving
a former employee and to a child custody dispute with his former
spouse, petitioner filed for bankruptcy and paid legal fees in
connection with the bankruptcy proceeding.
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In 1991, petitioner paid medical expenses relating to his
daughters, to employees of his warehouse, and to his own medical
needs.
Petitioner often traveled in his automobile to meet with
customers and prospective customers. Petitioner provided
refreshments for customers at his warehouse, and occasionally
petitioner purchased lunch for employees, for customers, and for
himself during meetings at restaurants.
On his 1990 and 1991 Federal income tax returns, petitioner
claimed deductions for alleged expenses relating to his scrap
metal recycling business. The deductions claimed include alleged
miscellaneous expenses relating to petitioner's home office, rent
and utilities relating to petitioner's home office and to the
warehouse, employee wages, fines and losses from burglaries,
legal fees, employee benefits, medical expenses, travel expenses,
and meal and entertainment expenses.
Allegedly due to a loss of many of petitioner’s books and
records during the bankruptcy proceeding, the only records
relating to petitioner's scrap metal recycling business that
petitioner produced to respondent’s revenue agent during the
audit and at trial were: (1) Copies of the computer spreadsheets
reflecting alleged daily and monthly expenses by category for all
of 1990 and 1991 except for one month of 1990; and (2) some of
the daily cash reports and receipts for 1990 and 1991.
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On audit, respondent determined that petitioner's claimed
home office expenses did not qualify for a deduction and that
petitioner’s books and records did not adequately substantiate
many of the claimed cash expenses relating to petitioner’s scrap
metal recycling business, and respondent generally disallowed all
expenses claimed as deductions where the nature and amount of the
expenses could not be substantiated by specific receipts or
billing statements.
Respondent refused to accept petitioner’s computer
spreadsheets as adequate substantiation of expenses incurred by
petitioner in his scrap metal recycling business because
respondent determined that the backup documentation was
inadequate. For example, during the audit and at trial,
respondent did not allow or concede deductions for claimed
expenses for employee wages where petitioner could not identify
either Social Security numbers or addresses of the employees, but
respondent did allow or concede deductions for wage expenses
indicated on the computer spreadsheets for employees for whom
petitioner provided Social Security numbers or addresses.
Respondent also disallowed claimed expenses for wages of the
warehouse foreman as reflected on the computer spreadsheets in
excess of $12,000 for each year.
The schedule below sets forth the expenses at issue herein
as reflected in petitioner’s computer spreadsheets, as claimed by
petitioner on his 1990 and 1991 Federal income tax returns, and
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the portions thereof now deemed by respondent to be allowable or
not allowable. Note that some of the categories of expenses are
different for each year:
1990
Computer Expenses Allowed By Disallowed By
Category Spreadsheets* Per Return Respondent Respondent
Rent $ 8,220 $ 11,765 $ 1,190 $ 9,855
Utility 3,687 21,279 19,604 1,675
Office 7,079 7,640 1,202 6,438
Wages 77,191 82,299 57,743 24,556
Fines & Losses 3,770 3,770 1,623 2,147
Legal 9,232 9,732 744 8,988
Emp. Ben. 0 1,320 414 906
$109,179 $137,805 $82,520 $54,565
* The 1990 spreadsheet totals are based on 11 out of 12 months.
As explained, one month of the 1990 spreadsheets was not put
into evidence.
1991
Computer Expenses Allowed By Disallowed By
Category Spreadsheet Per Return Respondent Respondent
Home Office $ 0 $ 2,291 $ 0 $ 2,291
Utility 2,115 2,115 1,944 171
Office 4,109 4,109 946 3,163
Wages 81,958 81,958 56,665 25,293
Fines & Losses 4,875 2,689 1,501 1,188
Legal 3,711 3,711 252 3,459
Medical 1,188 1,188 414 774
Travel 2,880 2,880 0 2,880
Meals & Ent. 5,303 4,244 2,582 1,662
$106 ,139 $105,185 $64,304 $40,881
The disallowed portion of the rent, utility, and office
expenses claimed for 1990 and of the utility and office expenses
claimed for 1991 relate to petitioner's home office.
OPINION
Under section 162(a), a taxpayer is permitted to deduct all
ordinary and necessary expenses paid or incurred in carrying on a
trade or business. Under section 280A, however, deductions
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associated with a home office are generally disallowed unless the
home office was used exclusively and regularly as the principal
place of business for the taxpayer.
Where a taxpayer’s business is conducted in part in the
taxpayer’s residence and in part at another location, the
following two primary factors are analyzed in determining whether
the home office qualifies under section 280A(c)(1)(A) as the
taxpayer’s “principal” place of business: (1) The relative
importance of the functions or activities performed at each
business location; and (2) the amount of time spent at each
location. Commissioner v. Soliman, 506 U.S. 168, 175-177 (1993).
Whether the functions or activities performed at the home
office are necessary to the business is relevant but not
controlling, and the location at which goods and services are
delivered to customers generally will be regarded as the
principal place of a taxpayer’s business. Id. at 176. The
relative importance of business activities engaged in at the home
office may be substantially outweighed by business activities
engaged in at another location. The Supreme Court has explained
as follows:
If the nature of the business requires that its
services are rendered or its goods are delivered at a
facility with unique or special characteristics, this
is a further and weighty consideration in finding that
it is the delivery point or facility, not the
taxpayer's residence, where the most important
functions of the business are undertaken. Id. at 176.
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The principal activities relating to petitioner's scrap
metal recycling business consist of the collection, processing,
and resale of scrap metal, the principal aspects of which are
performed at petitioner's warehouse. The warehouse appears to be
a facility with unique or special characteristics capable of
processing and storing scrap metal. These activities are not
performed in petitioner's home office.
The administrative, management, and other activities
performed in petitioner's home office certainly constitute a
relevant part of petitioner's business, but because the scrap
metal is collected and processed at the warehouse, the warehouse
is to be regarded as the principal place of petitioner's scrap
metal recycling business.
Petitioner argues that negotiations for the purchase and
sale of scrap metal that he conducts primarily over the telephone
from his home office constitute the principal activity of his
business. Petitioner, however, has not established in this case
that the actual purchase and sale of scrap metal is to be treated
as occurring in his home office, nor that negotiations for the
purchase and sale of scrap metal that are conducted over the
telephone from his home office constitute the principal activity
of the business.
Further, for expenses of a home office to qualify for
deductibility under section 280A, no personal use may be made of
the particular area of a residence that is used as the home
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office. Sec. 280A(c)(1). Petitioner maintained his home office
in the living and dining room area of the Estrella residence and
of the condominium. We are not convinced that petitioner used
these areas solely for his home office. We conclude that all
expenses relating to petitioner's home office, including rent,
utilities, and office expenses, were correctly disallowed by
respondent.
Turning to the other claimed expenses that remain in dispute
on the grounds that petitioner has not adequately substantiated
the business nature and amount of the expenses, it is well
established that taxpayers generally bear the burden of proof
regarding claimed business deductions. Rule 142(a); Welch v.
Helvering, 290 U.S. 111 (1933).
Under section 162, deductions are allowed for all ordinary
and necessary expenses paid or incurred during a tax year in
carrying on a trade or business. Cash basis taxpayers must
establish: (1) That the expenses were paid; (2) that they were
paid during the year in issue; (3) that they were paid in
furtherance of a trade or business; and (4) that they were
ordinary and necessary expenses of the trade or business. Sec.
1.162-1, Income Tax Regs.
Taxpayers are required to maintain adequate records to
substantiate business expenses and to enable respondent to
determine their correct tax liability. Sec. 6001. Where a
taxpayer does not have adequate records, the burden of proof
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bears heavily on the taxpayer. Ellis Banking Corp. v.
Commissioner, 688 F.2d 1376, 1383 (11th Cir. 1982), affg. in part
and remanding in part T.C. Memo. 1981-123; Cohan v. Commissioner,
39 F.2d 540, 544 (2d Cir. 1930).
Where taxpayers establish that they are entitled to
deductions for trade or business expenses but are unable to
adequately substantiate the exact amount of the expenses, we may
estimate the amount of the deductible expenses. Cohan v.
Commissioner, supra at 543-544. In order, however, for us to
estimate the amount of deductible expenses, taxpayers have an
obligation to provide some rational basis upon which reasonable
estimates may be made. Vanicek v. Commissioner, 85 T.C. 731, 743
(1985).
In this case, with regard to claimed wages of $24,556 for
1990 and $25,293 for 1991 that are still in dispute, both
petitioner and the warehouse foreman testified as to each of the
employees whose claimed wages are still in dispute. They
testified as to the employment relationship of each of these
employees with petitioner’s scrap metal recycling business during
1990 and 1991 and to the length of time employed. We find the
testimony of petitioner and of the foreman to be credible as to
these claimed employee wages. The wages paid to the employees
are also generally supported by the daily cash reports and
computer spreadsheets that are in evidence.
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We sustain in full the deductions claimed by petitioner for
1990 and 1991 for employee wage expenses, including the wage
expenses of the warehouse foreman.
With regard to claimed fines and losses of $2,147 for 1990
and $1,188 for 1991 that are still in dispute, petitioner admits
that some portion of the claimed fines and losses includes
nondeductible traffic fines. Petitioners offer no basis on which
we can make an allocation between allowable and nonallowable
fines and losses. We sustain respondent's disallowance of these
items.
The $8,988 for 1990 and $3,459 for 1991 in disputed legal
fees represent either clearly personal expenses or the business
nature thereof is not adequately established in the record. At
trial, petitioner conceded that $2,500 to $3,500 of these claimed
legal expenses represent personal expense, and petitioner did not
adequately document the nature of the remaining claimed legal
expenses. We sustain respondent's disallowance of the legal fees
still in dispute.
With regard to the $906 in claimed employee benefit expenses
for 1990 and the $774 in claimed medical expenses for 1991 that
are still in dispute, petitioner has failed to substantiate the
nature of these expenses. Petitioner admitted at trial that some
of these claimed expenses were incurred for personal medical care
of two of his daughters. We sustain respondent's disallowance of
the claimed employee benefit and medical expenses.
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With regard to the $2,880 in travel expenses and the $1,662
in meal and entertainment expenses that are still in dispute for
1991, the standard of proof for business travel and for business-
related meal and entertainment expenses is higher than the
standard of proof for other business expenses. Under section
274(d), deductions for business travel and business-related meal
and entertainment expenses are not allowable on the basis of
estimates and unsupported testimony of taxpayers. At a minimum,
taxpayer's records must show: (1) The amount of such expenses;
(2) the time and place such expenses were incurred; and (3) the
business purpose for which such expenses were incurred. Sec.
274(d).
Petitioner has failed to meet the level of substantiation
required for the claimed business travel and business-related
meal and entertainment expenses that are in dispute for 1991.
Petitioner did not present any receipts or underlying records
relating to these expenses. Mere entries on the computer
spreadsheets for "travel" and "meals/entertainment" do not
satisfy the substantiation requirements of section 274(d). We
sustain respondent's disallowance of the claimed travel, meal,
and entertainment expenses for 1991.
With regard to the additions to tax, under section 6662(a),
a 20 percent accuracy-related penalty is applicable to an
underpayment of tax attributable to either negligence or to a
disregard of rules or regulations (section 6662(b)(1)).
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Section 6662(c) defines "negligence" as any failure to make a
reasonable attempt to comply with the provisions of the Internal
Revenue Code. The term "disregard" includes any careless,
reckless, or intentional disregard of Treasury rules or
regulations. Sec. 6662(c).
Taxpayers are expected to maintain adequate records to
substantiate claimed deductions, and failure to maintain adequate
records may constitute negligence. Sec. 6001; Schroeder v.
Commissioner, 40 T.C. 30, 34 (1963). Even though a taxpayer's
records may be lost, the burden is generally still on the
taxpayers to substantiate deductions claimed with receipts and
other sufficient documentation and evidence. Petitioner in this
case has failed to meet his burden with regard to the adjustments
that we have sustained and has failed to convince us as to the
cause for his inability to provide at trial additional books and
records relating to his scrap metal recycling business.
With the exception noted below, we sustain respondent's
determination of the accuracy-related penalties for 1990 and 1991
with respect to all adjustments that we have sustained.
We believe, however, that the accuracy-related addition to
tax in this case is not properly attributable to those portions
of petitioner's tax deficiencies for 1990 and 1991 that relate to
the disallowed home office expense deductions that petitioner
claimed and that we have disallowed. Petitioner did not
demonstrate a careless, reckless, or intentional disregard for
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the law in claiming these deductions. We note that the Supreme
Court's decision in Commissioner v. Soliman, 506 U.S. 168 (1993),
was not made until 1993, and that prior thereto confusion existed
as to the proper legal standard to apply to home office expense
deductions. See, e.g., Soliman v. Commissioner, 935 F.2d 52 (4th
Cir. 1991), affg. 94 T.C. 20 (1990), revd. 506 U.S. 168 (1993);
Meiers v. Commissioner, 782 F.2d 75 (7th Cir. 1986), revg. T.C.
Memo. 184-607; Weissman v. Commissioner, 751 F.2d 512 (2d Cir.
1984), revg. T.C. Memo. 1983-724.
Decision will be
entered under Rule 155.